One thing that is evident is the degree to which the Commission is currently acting based on incomplete information when it comes to developing policy with regard to Rule 506 offerings, including with regard to the accredited investor definition. As the Commission noted in the release for the final rule lifting the ban on general solicitation in Rule 506 offerings, it has
“relatively little information on the types and number of investors in Rule 506 offerings.” This makes it difficult if not impossible for the Commission to reliably measure the likely impact of any changes to the accredited investor definition. This should not be seen as an excuse for inaction, however. Rather, the Commission should take immediate steps to collect the data that would allow it to better assess its policy options going forward.

The Committee goes on to make 5 specific recommendations. I listed them in my last blog post.

The Discussion At the Last Committee Hearing

At the last Investor Advisory Committee hearing, there was a good discussion of this point about not having enough information to make an informed decision. I transcribed a part of the last hearing on this point. Here is how it went:

Joseph V. Carcello had this to say:

Could I just make a broader general point that I think is important for the staff. You know, this is an area where there’s a surprising lack of even basic descriptive statistics. What, for example, is the, you know, distribution of the size of investments that are made by individuals into Reg. D private placements? What percentage of these investments come in from accredited investors? What percentage come in from unaccredited investors under 506 who are relying on purchaser representatives? What do we know in general about the risk and return profile of private placement investments? What percentage of them even return the initial investments? What’s the variance? How does that compare to the risk and return that you would get in a, you know, index fund or what have you? These are basic descriptive statistics about the market as a whole that to the best of my knowledge really are lacking. And it seems that if we want to do the best possible job for all participants in the process, for the companies that are offering securities pursuant to Reg. D, for the investors that are buying, and for the intermediaries in the market, it would behoove all of us to get some of this basic data. And the only way we’re going to be able to get it is unfortunately if the Commission rolls up its sleeves and does, you know, survey work in this area.

To this, Barbara Roper responded as follows:

Thanks, Joe. And I would just add there is—one of the points that we discuss in our draft recommendation is this notion that the Commission is operating to a large extent in the dark in developing policy in this area. There is, for example, an acknowledged problem that many Reg. D offerings do not file Form D. We don’t know how many. There’s, because of the way the regulations are written, even for those that do file the form, there isn’t a closing form. So there’s a lot you don’t know about what they actually raised, and what then happened with the offering. And so we anticipate that included in our recommendation would be a restatement of our previous recommendation that the Commission approve the changes to the Form D filing requirement that would allow it to collect additional information to assess some of these issues. That staff has done work, you know, if you read the economic analysis in the General Solicitation Final Rule—you know, they’ve reported what they know, based on the information that they get from the—you know, from the forms that are filed. And it’s useful. But it is, by definition, an incomplete data set, and we don’t even know how incomplete. And also arguably not representative, since those issues that actually take the step of file are presumably sort of different from those that don’t. So, I think, absolutely, I agree, Joe, that there is a useful place for more data in this and that, as you know, that will be reflected in the recommendation that comes from our subcommittee.

Then James Glassman, Executive Director of the George W. Bush Institute, at about the 1:04 mark, said this:

In your comments you alluded to the fact that there could be an economic effect if there was a straight inflationary increase in the limits. I like to just second what Joe said about the importance of research. It would be good to do some economic research on what would be the effects if we made any changes at all on the economy; I think there would be some economic effects. I just want to say I think that the SEC tries to be diligent in these efforts but in general frequently in the dark about economic effects. I think it is important for the SEC to look at those kind of things. Here is an perfect example where we can do research, not just in the areas that Joe talks about, but in broader economic terms. I think that should be a strong part of the recommendations; we shouldn’t make changes unless we know what the effects are going to be or get a pretty good estimate of what they are going to be.

I do not think the committee or anyone else should be revising or recommending revising the definition of “accredited investor” until the economic impacts are understood.

How Many Future Jobs Will Be Vaporized?

So, for example, if we simply adjust the financial thresholds for inflation, and 2/3rds of currently qualifying angel investors no longer qualify–how many jobs that would otherwise have been created will not be? Shouldn’t we get a reliable economic estimate before we proceed?

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Joe, awesome that you are pulling out these key quotes, surfacing them. It’s troubling that such fundamental changes to private financing are being considered without any sense of what needs to be mended.

California recently changed its 25102(f) form (which takes 15 minutes to file). It *looks* like one of the goals is to collect filing data into a searchable database.
The SEC could start by making Form D as easy to file as that, and then looking at the data they collect.

They should make it easier to file and provide incentives to file of some kind.

Dan Rosen

Thank, Joe. Their approach is “let’s collect data about what’s going on so we can figure out how we regulate.” This is fundamentally the wrong approach. In fact, we KNOW that there isn’t a problem – the angel asset class has remarkably little/no fraud. It is hard enough to be an angel investor – investing your own money in illiquid, high-risk startups. STOP THIS ridiculous search for problems where there is none.

I hope that in saying that economic research *should* be “reflected in the recommendation that comes from the [Investor Education] Subcommittee” and “[thinking] that [research] *should* be a strong part of the recommendations” are more committal than they sound.

How on earth could any committee even consider tightening the regulations on the barrier-to-entry for startup investing? In an era where crowdfunding is growing exponentially, and holds the power to accelerate growth in every sector, this entire topic seriously makes me question the good judgment intentions of some of our lawmakers. How can the SEC operate in the dark, without a data-driven apporach, on something that has massive implications for our middle class from both the entrepreneurial side and the investment side?

Is more reasoning provided for these constraints, other than the ridiculously antiquated guise of holding a high bar for “accredited investor” as *protection* for widows/the middle class etc making misinformed investments? How is the stock market or government-sanctioned lottery programs allowed to exist in this case lol?

The friends, families and communities (online & offline) that form personal connections, or identify with the team, mission and plan of startups, are the best informed about the investment they are making, no matter what social strata they fall into. Anyone with access to the internet and thoughtful google-searches can make an educated decision about where they put their money if they do their research. Gatekeeping financial reward from early-stage investment to those with over $1M in assets is at best, an outdated, ridiculously arbitrary way to constrain startups and the people who believe in them, and want to invest. At worst, it is yet another way to empower entrepreneurs who came from wealth, and investors who came from wealth – and keep the flywheel of startup wealth ‘in the family’ of the wealthiest class – while restricting access to all others.

For those of us who make the bold leap to launch startups and don’t have a dozen wealthy uncles, if we launch a youtube/kickstarter campaign to find our investment communities out in the open – slap on the wrist with “General Solicitation” risks and then Angels/VCs are supposedly wary of getting involved, and of course we still have the “Accredited” barrier to deal with even then. Being a startup CEO, this system is both aggravating and alarming sign of lawmakers priorities on the matter of encouraging new business growth. I’m learning firsthand how working with angels and VCs is a world that functions in a very slow way, until you know the right people who can give warm intros to the organizations/people who meet the accredited quota. Your ability to connect to the middle class investor, and even moderately wealthy investor that don’t meet the accredited bar, are meaningless when it comes to startup fundraising. Bet it helps to come from wealth when raising funding doesn’t it? Thank heavens that Kickstarter, Angellist etc are over time going to disrupt the system, and increase awareness in the free-market about the unmet demand from all classes, for investing early-stage. Only then will we likely see the right, well-funded, lobbies show up to change the game.

Ok, I’ll stop bitching on my soapbox and get back to unscalably connecting to the Silicon Valley 1%’ers that hold all the keys to the gates for our first round of funding ;P. In the words of good old Mr. Shakur, “that’s just the way it is.”

Well-written article Joe, really appreciate you giving this issue the voice it deserves.